Paul Volcker vs. JPMorgan’s London Whale
He swept out the Senate hearing room surrounded by an entourage, causing a stir as his tall, looming figure passed through the crowd. Before he got in the elevator, one of his assistants handed him a copy of the remarks he just delivered: an admirer wanted an autograph.
“Does this happen to you often?” he was asked by a reporter.
“All the time,” he said, scribbling his signature.
George Clooney? Mark Ruffalo?
Nope. It was Paul Volcker, the 84-year-old former chairman of the Federal Reserve who still manages to leave veteran legislators a bit starstruck. Widely credited for ending the stagflation crisis of the 1970s, Volcker, the godfather of central banking, has resurfaced as Washington has been soliciting his advice about how to rein in Wall Street. JPMorgan’s $2 billion loss announced on Thursday has made the spotlight on Volcker even brighter.
Volcker, who served as Fed chairman during the Carter and Reagan administrations, didn’t write the rule that bears his name. But he has since risen to defend the Volcker Rule, which prohibits government-backed banks from making certain kinds of speculative bets for their own benefit, rather than their clients’. And he made clear on Capitol Hill this week why he believes such restrictions are necessary.
“It is surely inappropriate that those activities be carried out by institutions benefiting from taxpayer support, current or potential,” he told the Senate Banking Committee on Wednesday afternoon.
That was the day before JPMorgan Chase owned up to its huge loss on a bad bet that looks, to many, like the kind of gamble that the Volcker Rule was meant to prevent when it was passed in 2010 as part of the Dodd-Frank overhaul.
It’s unclear whether the rule would have kept JPMorgan trader Bruno Iksil in the U.K. — nicknamed the “London Whale” — from taking such a high-risk bet. The bank essentially carried out a complicated hedge on a stack of corporate bonds, which the Volcker Rule, as currently drafted, would permit. The problem, however, is that JPMorgan’s bet seems to go above and beyond what a hedge is meant to do: Rather than simply buy insurance to protect the corporate bonds, Iksil reportedly bet as much as $100 billion that those firms would never default.
For a firm like JPMorgan, $2 billion is a drop in the bucket. The banking giant isn’t expected to fail or need a bailout any time soon. But the big loss shows how Wall Street banks are still able to make risky bets for their own benefit. And JPMorgan’s embarrassment won’t necessarily stop the same from happening elsewhere, potentially increasing risk to the financial system. In fact, similar bets by JPMorgan’s chief investment office made the bank $5 billion in 2010. Other banks could decide that gambling with their money is still worth the that chance — and that they can do a better job than JPMorgan did at pulling it off.
That’s why supporters of a strong Volcker Rule — which federal officials are still finalizing before the measure’s July start date — are now clamoring for a more expansive regulation with fewer loopholes. And Volcker’s own words before the Senate this week could strengthen their argument. If banks are still allowed to treat trading like a casino, yet are big enough to warrant government support if things go awry, they’re benefitting from the assumption that they’re Too Big To Fail — “that losses will be socialized, with the potential gains all private,” as Volcker explained.
After the financial meltdown, “understandably, the public feels aggrieved and wants serious reform,” Volcker said Wednesday. “The Volcker Rule is part of this formula.” (I asked Volcker’s office whether he had any thoughts about the JPMorgan debacle, but he wasn’t available.)
What, then, is holding back regulators from implementing a strong, clear Volcker Rule? Volcker himself acknowledges that the draft of the rule, at 300 pages, has gotten bloated and complex partly because bank lobbyists are pushing for carve-outs.
“I could give you stories all day about lobbyists making things more complicated,” Volcker said as he left the hearing room. “They may do it [because] they want to disrupt the whole process, but they ... say, ‘We want to make sure that this particular little operation we have — is it good or bad?’”
Volcker did say that he was “encouraged” by the progress that regulators appear to be making on finalizing the rule that bears his name. And — perhaps more than do his acolytes on Capitol Hill — he believes that banks will comply.
“You don’t trust the banks?” he asked, as he left the Senate building. “I implicitly trust the banks.”